The Challenges and Dangers of Short Sales
June 3, 2013
What Exactly is a Short Sale of a House?
In a short sale, a house which is worth less than the liens owed against it is sold by “shorting”—underpaying—one or more of the lienholders. The house can’t be sold for enough money to pay the lienholders in full (while also paying any realtor and closing costs).
Note that the liens can include not just the ones you intentionally placed on the property, like the first and possibly second and third mortgages, but also involuntary ones, including some that you may not even know about. These can include judgment liens, income tax liens, child support liens, utility and local governmental liens, construction liens, and property taxes. In a short sale, all such lienholders must consent and release their liens, or the sale won’t happen.
The Attraction of a Short Sale
For a homeowner who cannot afford the debts on a house, and is facing the threat of a foreclosure, the main perceived benefit of a short sale is that it avoids a foreclosure on the homeowner’s credit record. And it gets the homebuyer out of an unsustainable situation.
But this assumes, first, that the short sale will actually occur, and second, that there are no detriments that outweigh this perceived benefit. More about those in a moment.
Be aware that because of the upheaval in the residential real estate and mortgage market in the last 5 years or so, and the millions of people whose home were foreclosed—often through virtually no fault of their own—there are indications that a foreclosure is causing less detriment on credit records. Depending on the details of a short sale, it will almost certainly have some detrimental credit record impact itself. So there is less credit record difference between a short sale and a foreclosure. This reduces or eliminates one of the main justifications for short sales, even before getting to the problems with them.
Short Sales Have Two Main Problems.
One: they are often do not succeed—the sale does not close–often wasting valuable time, effort, and sometimes money, that could have been better invested in a successful alternative.
Two: they can be dangerous, with unexpected traps that either spring at you when you’re under pressure to close the sale or that remain hidden until it’s too late.
Challenges to a Successful Short Sale
Short sales are difficult to close because:
Uncooperative mortgage lenders: Although this may be less of a problem now after so many attempted short sales during the last few years, working with your mortgage lender(s) can be very difficult. To pull off a short sale, often the first mortgage lender has to agree to be paid less than its full balance to give some of the sale proceeds to a junior lienholder or two. The reason a first mortgage holder may be willing to do this is that getting paid a little less can be better than incurring the delay and cost of going through foreclosure. But many mortgage companies were not set up to handle such negotiations, especially early in the foreclosure crisis. Also, you often have to work through a servicing company, whose financial incentives may well not encourage short sales. So either intentionally or out of incompetence they may be difficult to work with, and can even sabotage a sale.
Getting everybody to agree can be challenging, especially if there are many lienholders: Every lienholder has the legal right to demand payment in full, and those at the end of the line who are slated to get nothing may have little to lose by being obstinate. If any of these lienholders have an axe to grind—such as an ex-spouse or angry judgment lien holder—getting them to agree can be that much harder.
Realtors and others involved with real estate sales often have more to gain than you: There are good reasons why bankruptcy judges and trustees are wary of short sales, because they often see less benefit to the homeowners than to the real estate middlemen. Some short sale specialists know what they are doing and are ethical, but be very careful of those who make promises that sound too good to be true.
Short Sales Are Dangerous
Potential liability from unpaid balances: Be sure that you will not owe anything to your mortgage lender(s) after the sale. Get legal advice to determine if the settlement documents legally cut off any potential liability. Make sure you know whether and how much you would continue to be liable to any lienholders who are giving up their liens to allow the sale to proceed. Especially be on the lookout for the likelihood that in the midst of the negotiations you will be pressured to accept some continuing liability in order to allow the sale to close.
Potential tax consequences: Debt forgiveness can be treated as income, subjecting you to income tax unless you fit within one of the exceptions. Discuss this with an appropriate tax specialist about this before investing any time or expectations in the short sale option.
Please see our next blog (in 2 weeks) for bankruptcy alternatives that can often be better than a short sale.